By Sam Jaffe
Last year was pretty good for investment bankers. Despite the severe market downturn, merger-and-acquisition activity came close to breaking the record set in 1999. But despite the bear's grip on the stock market, don't expect 2001 to be significantly different when the value of all the deals is added up.
Even though the Standard & Poor's 500-stock index is down 8% for the past 13 months, plenty of companies are still hoping to restructure or be bought out. In addition, many larger companies are expected to divest subsidiaries to improve profitability as the economic slowdown continues.
NO NEW RECORDS.
The big difference: Not as many megadeals like those that dominated the financial news in the past year, such as the $111 billion AOL-Time Warner merger and General Electric's $46.5 billion Honeywell acquisition. Instead, there will be more activity among smaller and midsize companies. "Obviously, some of the larger multibillion deals will slow down," says Ben Buettell, a managing director of the Chicago investment-banking firm Houlihan Lokey Howard & Zukin. "But there will be just as much activity in the broader middle market -- smaller public companies and private firms."
Clearly, 2001 is unlikely to set any eye-popping records, thanks to the reduced market value of most companies after the stock-market decline of the past year. The record was established in 1999, when a total of $1.45 trillion worth of disclosed deals involved U.S. companies. Last year came close, at $1.41 trillion. The record easily would have been eclipsed if not for a drastic slowdown in the fourth quarter, when only $278 billion worth of mergers was announced, 16% below 1999's fourth quarter. "There's no way we'll see a return to last year's numbers, unless there's a massive turnaround in the stock market," says Robert Teitelman, editor in chief of The Daily Deal, a merger newsletter.
The fourth-quarter slowdown has continued in the first quarter even though there's hope that later this year, the economy and the market will be in better shape. "Economic slowdowns cause a psychological shift among company management," Buettell says. "Rather than pursuing other companies, they tend to turn more introspective and rethink their own business plans." As a result, he expects M&A activity to be somewhat disappointing.
Some sectors, though, might see increased activity. The food industry has already had three major deals, worth $28.6 billion, in the past two months. "When there's a flurry of activity in one area, it tends to make the other companies in that sector anxious to become acquirers rather than be acquired," Buettell says.
The telecommunications sector also could see an enormous boost in merger activity. Much of the activity may originate overseas, especially if the dollar continues to weaken against the euro. "If the euro rises, it will be a significant catalyst for European companies to come in and make offers for American firms," Teitelman says. "They've been waiting in the wings for some time now."
One factor that could alter the M&A landscape in 2001 is a key change in an accounting rule known as pooling of interest. Most deals are accounted for using this method, which allows the acquiring company to avoid counting the purchase cost against its earnings. That loophole will be eliminated as of June 30, 2001, a deadline imposed by the Financial Accounting Standards Board. In this unforgiving market environment, many companies might be wary of acquiring others when they have to reduce the amount of earnings they declare. But the practical effect of the accounting change might not be as prominent as many fear.
"In the short term, some deals won't get done because of the accounting-rule change," Teitelman says. "But longer term, companies will find a way around it." Not surprisingly, one sector that likely won't see much activity is the dot-coms. The reason: A drop in stock market interest has stripped them of their capital, and they have very few real assets left. "There's just nothing there to acquire," Buettell says. "Even their hard assets have little value."
But that doesn't mean there won't be a lot of merger activity among companies in distress. This growing area involves companies that purchase others in bankruptcy protection or close to it. Traditionally, most "vulture investors" waited for a distressed company to complete the bankruptcy process and then purchased its assets. But now many are navigating the legal problems of buying a company that isn't officially bankrupt yet, which can sometimes be even cheaper. Buettell, whose firm specializes in such activity, thinks the coming year will be a good one for his firm: "A downturn for the economy usually means an upturn for us."
Jaffe writes about the markets for Business Week Online in our daily Street Wise column
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Edited by Beth Belton